Coty Inc. reports first quarter fiscal 2019 results

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Coty Inc. reports
first quarter fiscal
2019 results
November 7, 2018
Coty Inc. Reports First Quarter Fiscal 2019 Results
First Quarter Results Impacted by Supply Chain Disruptions
EPS Growth Supported by Fixed Cost Improvement and Favorable Tax Impact
NEW YORK - November 7, 2018 -- Coty Inc. (NYSE: COTY) today announced financial results for the first quarter of fiscal year 2019, ended September 30, 2018.
• 1Q19 reported net revenues of $2,031.3 million decreased 9.2%, with a like-for-like (LFL) revenue decline of 7.7% as we encountered several temporary supply chain-related headwinds. We estimate these factors cumulatively negatively impacted LFL by approximately 5%, implying an underlying 1Q19 decline in the low single digits, with underlying declines limited to the Consumer Beauty division.
• Specific supply chain headwinds included:
◦ Warehouse and planning center consolidation disruptions in Europe and the U.S., which impacted all three divisions;
◦ Component shortages from certain external suppliers, which impacted Luxury; and
◦ The U.S. Hurricane Florence in the second half of September, which significantly impacted our manufacturing plant and distribution center in North Carolina, which primarily impacted the Luxury division.
Gross Margin
• 1Q19 reported gross margin of 60.2% decreased by 70 bps from the prior-year period, while the adjusted gross margin of 60.4% decreased by 120 bps, primarily driven by the impact of supply chain disruptions, including higher freight costs, on both Consumer Beauty and Luxury.
Operating Income:
• 1Q19 reported operating loss of $20.7 million decreased from reported income of $29.5 million.
• 1Q19 adjusted operating income of $140.8 million, down by 28% from the prior year with a margin of 6.9%, which included approximately $60 million of impact from the temporary headwinds discussed above.
• The adjusted operating income decline reflected the net revenue and gross margin contraction, as well as an approximately 3.8% FX headwind, in part offset by significant progress in fixed cost reduction versus the prior year as we delivered on our synergy commitments.
Net Income:
• 1Q19 reported net loss of $12.1 million improved from a loss of $19.7 million in the prior-year, while the adjusted net income of $80.5 million grew 6% from $76.3 million in the prior year, primarily due to a $32 million tax benefit in the quarter, coupled with lower interest expense, tied to higher EUR borrowings in 1Q19.
Earnings Per Share (EPS):
• Our 1Q19 reported earnings per share of $(0.02) improved from $(0.03) in the prior-year, and the adjusted EPS of $0.11 improved from $0.10 in the prior year. The aforementioned tax benefit contributed $0.04 to EPS.
Operating Cash Flow & Net Debt:
• In 1Q19, net cash provided by operating activities was $(81.9) million, down from $(8.9) million in 1Q18 primarily driven by continued pressures on working capital, largely connected to our supply chain disruptions, as well as an increase in integration and restructuring cash costs of over $15 million to approximately $140 million in 1Q19.
• Our 1Q19 free cash flow of $(215.5) million decreased from $(120.3) million in the prior year, driven primarily by the reduction in operating cash flow.
Net debt of $7,661.3 million on September 30, 2018 increased by $369.7 million from the balance of $7,291.6 million on June 30, 2018, resulting in a last twelve months Net debt to adjusted EBITDA ratio of 5.8x compared with our June 30, 2018 ratio of 5.3x.
Management Comments
Commenting on the financial results, Camillo Pane, Coty CEO said:
"We are very disappointed with the supply chain disruptions that we have experienced over the last quarter and the resulting poor Q1 financial performance. While we had anticipated some level of disruption in the first quarter from warehousing and planning consolidation, the increased scope of the disruptions resulted in much weaker results than previously expected. We have been working to remedy the supply chain issues and expect to temper the headwinds in 2Q19, and have them be substantially resolved in 3Q19, although we do not expect to fully recover the 1Q19 financial impact in the balance of FY19.
As a result of these disruptions, we have decided to modify our distribution center consolidation plan for the remainder of the year to minimize business impact. With a healthy synergy delivery already in 1Q19, these modifications should have no impact to our commitment of $225 million of synergies in FY19 and $750 million total by the end of FY20.
By division, underlying consumer demand in Luxury and Professional Beauty remains strong, and if we exclude the supply chain disruptions, both divisions would have reported solid net revenue growth in 1Q19 consistent with their FY18 trend, driven by strong innovation and excellence in execution. However, Consumer Beauty's underlying high single digit revenue decline clearly reflects category weakness in developed markets, continued competitive pressure and performance challenges with some of our brands, as well as the repercussions of our severe supply chain disruptions on our Consumer Beauty gross-to-net, including customer penalties and increased promotional support. From here, the pathway to stabilization of Consumer Beauty will focus on: 1) strengthening operational discipline, including restoring service levels; 2) actively improving gross-to-net as supply chain headwinds abate; 3) refocusing investment from lower priority to higher-potential brand-country combinations; 4) an increased focus on cost structure to reflect the top-line trajectory; and 5) a more pronounced shift in investments towards new growth channels.
To conclude, 1Q19 was a disappointing setback in achieving our financial targets and strategic goals, and we are working hard to solve the issues. With the P&G Beauty integration near completion, and after we have overcome the internal challenges, we will be better equipped to focus more externally, so that we can fully capitalize on the exciting and dynamic changes in the beauty industry. We remain absolutely convinced that the fast-paced and ambitious transformational agenda we are pursuing, including comprehensive upgrades to our systems, processes, culture, and people, is ultimately building a much stronger Coty for the long term."
As we look to the remainder of the year:
2Q19: We expect underlying YoY net revenue trends in 2Q19 to improve versus 1Q19 across all three divisions, inclusive of expected supply chain headwinds. We expect Luxury and Professional Beauty to return to LFL net revenue growth in 2Q19, while Consumer Beauty YoY trends should improve to a high single digit decline. On adjusted operating income, we expect 2Q19 adjusted operating income to be moderately lower YoY, driven by remaining supply chain impacts and FX headwinds. The 2Q19 year-over-year adjusted EPS comparison will be pressured by the $42 million positive tax settlement recorded in 2Q18.
FY19: Despite the supply chain headwinds, we continue to expect operating profit and margin growth in FY19, driven by significant progress in fixed cost reductions and synergy delivery. However, we need some more time to assess the financial impacts of the continuing supply disruptions and, at this stage we are not providing any further guidance, but expect to provide an update on our outlook on the next earnings call.
Deleveraging remains a top priority in FY19 and beyond. We remain committed to our target of achieving a Net Debt to adjusted EBITDA ratio of below 4.0x by the end of calendar 2020 and we expect positive free cash flow in the remaining quarters and in FY19. Our liquidity position is substantial, with significant flexibility from over $2 billion of revolver availability.

First Quarter Fiscal 2019 Business Review by Segment

In 1Q19, reported Luxury net revenues of $792.9 million increased by 3.7% versus the prior year. On a LFL basis, Luxury net revenues declined by 2.1% due to the supply chain impacts referenced above. We estimate that the combination of these factors negatively impacted the Luxury division by approximately 7%, implying mid single digit underlying growth.
Despite these challenges, we continued to see solid in-market momentum, especially for the Gucci, Tiffany, Miu Miu and Chloe brands. Burberry delivered solid results in 1Q19, and will become part of our LFL base in 2Q19. From a regional perspective, we achieved strong growth in emerging markets, in particular in Asia, with solid results in Europe. North America and travel retail were disproportionately impacted by the hurricane and the supply chain disruptions, which drove net revenue declines in both businesses. We expect to fully recover the hurricane-disrupted product shipments in the critical 2Q19 holiday season, with no net sales lost between 1Q19 and 2Q19, and are working hard to address the supply chain headwinds.
The Luxury division delivered reported operating income of $48.7 million, a decline of 14% vs. the prior-year period, while adjusted operating income was $101.6 million, reflecting very strong 13% growth from the prior-year, despite the supply chain impact. The adjusted operating margin was 12.8%, up 100 bps versus 1Q18, fueled by strong fixed cost control and the phasing of marketing investments.
1Q19 Consumer Beauty net revenues of $828.8 million declined 20.6% on a reported basis and declined 14.0% LFL. We estimate that the supply chain disruptions negatively impacted the division by approximately 5%, implying a high single digit underlying decline. The sequential deterioration in Consumer Beauty's business trends reflected the impact of the supply chain disruptions on the division, including customer penalties and increased promotions which reduced net revenues. Top-line was further impacted by the continued weakness in U.S. and Europe mass beauty categories, coupled with previously flagged distribution losses.
While our developed markets deteriorated in the quarter, we saw modest growth in ALMEA supported by high single digit LFL growth in Brazil and the Middle East & Africa, partially offset by a slowdown of our brands in Australia. These results were underpinned by strong share gains in the region, particularly in Brazil.
By category, in retail hair, Wella - our largest Coty brand - drove solid net revenue growth and share gains in a number of key emerging markets, fueled by color and styling products, while Clairol remained under pressure. Our color cosmetics business remained challenged, reflecting the significant impact of supply chain disruptions, resultant increases in promotional activity and market share losses. As part of our plan to revitalize CoverGirl, we are pleased to announce that CoverGirl has become the largest cosmetics brand to be Leaping Bunny certified by Cruelty Free International, which is a significant milestone in our journey to reconnect the CoverGirl brand with consumers and to remain a thought leader in the beauty industry. The majority of CoverGirl's recent innovation delivered strong growth this quarter.
For Younique, while year-over-year sales trends improved sequentially, 1Q19 revenue performance was below the business's long term trajectory as strong presenter sponsorship and growth in gross revenues was more than offset by increased promotional activity and compensation plan adjustments. While these adjustments have not translated into improved presenter retention at the pace initially expected, we firmly believe that traction in the new subscription and loyalty programs, compensation plan refinements and the continued broadening of the Younique product portfolio will support strong momentum in Younique in the coming years.
The reported operating loss in 1Q19 of $18.6 million declined from $61.9 million in the prior year period, and adjusted operating income of $14.8 million declined from $88.3 million in the prior year period, resulting in an adjusted operating margin of 1.8%. The margin pressure was largely driven by the combination of weak top-line results and supply chain disruptions. While the profit performance of the Consumer Beauty division was disappointing, we have benefited, and expect to continue to benefit, from the substantial reduction in our fixed cost base.
Professional Beauty 1Q19 net revenues of $409.6 million declined by 4.9%, with LFL down 2.6%. The disruption of service levels at our North America distribution center had a significant negative impact on our North America hair and nail businesses. We see no underlying change to the strong customer demand for our brands in North America or to the overall health of our salon professional business. We estimate that the supply chain disruptions negatively impacted revenues by approximately 4%, implying low single digit underlying net revenue growth. We continued to see solid momentum in the rest of the business, led by our largest global brand Wella, with solid growth in Europe and very good growth in ALMEA and in ghd. The strong in market results were also driven by the promising start of key innovations like Wella Koleston Perfect with ME+ and ghd Platinum+ styler.
Professional Beauty reported operating income of $5.0 million improved from a reported loss of $1.7 million in the prior year period, while adjusted operating income grew 41% to $23.8 million. The Professional Beauty adjusted operating margin of 5.8% grew 190 bps, despite the supply chain impacts, driven by mix-led margin benefits and good fixed cost reduction.
North America
• North America net revenues of $644.9 million, or approximately 32% of total net revenues, decreased 14% as reported and declined 15% LFL reflecting the impact of the U.S. hurricane on our North Carolina facilities, the supply chain disruption in our Professional Beauty distribution center and the continued headwinds in our Consumer Beauty U.S. business including the supply chain disruptions.
• Europe net revenues of $872.2 million, or approximately 43% of the total, declined 10% on a reported basis and declined 9% on a LFL basis with growth in Luxury and Professional Beauty largely offset by declines in the travel retail channel, driven by supply chain disruptions, and Consumer Beauty, driven by performance challenges and supply chain disruptions.
• ALMEA net revenues of $514.2 million, or approximately 25% of the total, continued to show strong momentum despite impact from the supply chain disruptions. Revenues decreased 1% as reported, but grew 5% LFL fueled by very strong growth in Luxury and Professional Beauty, and modest growth in Consumer Beauty reflecting the return to growth in Brazil and strong performance in Middle East & Africa.
Cash Flows
• In 1Q19, net cash provided by operating activities was $(81.9) million, down from $(8.9) million in 1Q18,  primarily driven by continued pressures on working capital in large part connected to our supply chain disruptions as well as an increase of over $15 million in integration and restructuring cash cost outflows.
• Our 1Q19 free cash flow of $(215.5) million decreased from $(120.3) million in the prior year driven by the reduction in operating cash flow.
• In 1Q19, we distributed $(93.8) million in quarterly dividends.
• Cash and cash equivalents of $423.3 million increased from $331.6 million on June 30, 2018. Total debt of $8,084.6 million increased by $461.4 million from June 30, 2018, with net debt of $7,661.3 million up $369.7 million from the balance of $7,291.6 million on June 30, 2018. This net debt increase reflects negative free cash flow of $(215.5) million, the dividend payment of $(93.8) million, and the purchase of the Escada license of $(40.8) million.
Other Company Developments
Other company developments include:
• On November 7, 2018, Coty announced a dividend of $0.125 per share, payable December 14, 2018 to holders of record on November 30, 2018. This dividend will be considered a return of capital.
Conference Call
Coty Inc. will host a conference call at 8:00 a.m. (ET) today, November 7, 2018 to discuss its results. The dial-in number for the call is (866) 834-4311 in the U.S. or (720) 405-2213 internationally (conference passcode number: 2361249). The live audio webcast and presentation slides will be available at http://investors.coty.com. The conference call will be available for replay.
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